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1997

Apportioning Basis: Partial Sales, Bargain Sales and the Apportioning Basis: Partial Sales, Bargain Sales and the

Realization Principle Realization Principle

Stephen B. Cohen Georgetown University Law Center, cohen@law.georgetown.edu

This paper can be downloaded free of charge from:

https://scholarship.law.georgetown.edu/facpub/1589

Stephen B. Cohen, Apportioning Basis: Partial Sales, Bargain Sales and the Realization Principle,

34 San Diego L. Rev. 1693 (1997)

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Part of the Tax Law Commons

Apportioning Basis: Partial Sales,Bargain Sales and the Realization

Principle

STEPHEN B. COHEN*

I. INTRODUCTION

The Internal Revenue Code generally taxes appreciation in the valueof property only on realization, defined to mean when property is soldor exchanged In measuring gain on a sale or exchange, an allowancemust be made for the return of capital, referred to as basis.2 Basisoffsets the amount realized-that is, the price received for property-inorder to calculate taxable gain?

A partial sale occurs when only a part of property is sold. In theory,there are three possible methods of determining basis and therebymeasuring the gain on a partial sale: frontloading, apportionment, or

* Professor of Law, Georgetown Law Center. I am grateful to MarvinChirelstein, Daniel Halperin, Laura Sager, Lynn Stout, and David Weisbach forcomments on an earlier draft.

1. I.R.C. § 61(a)(3) (1997) defines gross income as including "[g]ains derivedfrom dealings in property." Treas. Reg. § 1.61-6(a) (1957) explains this phrase asmeaning "[glain realized on the sale or exchange of property." In a few instances, theCode does tax unrealized appreciation. Such instances include the treatment of dealersin securities under I.R.C. § 475, commodity straddles under I.R.C. § 1256, and originalissue discount under I.R.C. § 1272.

Unless otherwise noted, when this Article refers to a code section or to "the Code,"it is referring to the 1986 Internal Revenue Code, as amended and in effect for 1997.

2. See generally 2 BORis I. BrrrKER & LAWRENCE LOKKEN, FEDERAL TAXATIONOF INCOME, ESTATES AND GiFrs 41.2.1 (2d ed. 1989).

3. § 1001(a).

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bactdoading. Frontloading allows up to the entire basis of the originalproperty to offset the amount realized from selling only part. Apportion-ment uses a fraction of the entire basis, equal to the fraction of theproperty that has been sold. Backloading permits none of the basis tooffset the amount realized, until the entire gain on the original propertyis taxed in full.4

In practice, apportionment has been the general rule since enactmentof the modem income tax eighty-five years ago.5 Even with this longhistory, the tax literature contains no discussion of why basis should beapportioned on partial sales.6 This is true even though the questionaffects the tax treatment of a variety of other transactions, includingbargain sales.

A bargain sale, also referred to as a part sale/part gift, occurs whenproperty is intentionally sold for less than fair market value. The taxlaw permits basis to be frontloaded on a bargain sale, that is, the entirebasis may offset the amount realized.7 This result has been called

4. To illustrate, assume that a parcel of land costs 200 (with the basis undersection 1012 being its cost), that the parcel appreciates by 100, and that one-half of theparcel is sold for 150. Under frontloading, the sale of one-half the parcel produces nogain, since up to the entire 200 basis is available to offset the 150 amount realized.Under apportionment, the sale of one-half the parcel produces a 50 gain, which equalsthe 150 amount realized offset by 100, one-half of the entire basis. Under backloading,the sale of one-half the parcel produces a 100 gain, which equals the 150 amountrealized up to the 100 gain on the entire property.

5. Treas. Reg. § 1.61-6(a) states:When a part of a larger property is sold, the cost or other basis of the entireproperty shall be equitably apportioned among the several parts, and the gainrealized ... on the part of the entire property sold is the difference betweenthe selling price and the cost or other basis allocated to such part.6. Treatises and casebooks explain the mechanics of the apportionment rule,

without mentioning possible reasons for it. See, e.g., 2 BrrrKER & LOKKEN, supra note2, 41.7; MICHAEL J. GRAETZ & DEBORAH H. SCHENK, FEDERAL INCOME TAXATION:PRINCIPLES AND POLICIES 156 (3rd ed. 1995); WILLIAM A. KLEIN & JOSEPH BANKMAN,FEDERAL INCOME TAXATION 166-71 (11th ed. 1994); PAUL R. MCDANIEL ET AL.,FEDERAL INCoME TAXATION: CASES AND MATERIALS 237-39 (3rd ed. 1994).

7. Treas. Reg. § 1.1001-1(e)(1) (as amended in 1994) states, "Where a transferof property is in part a sale and in part a gift, the transferor has a gain to the extent thatthe amount realized by him exceeds his adjusted basis in the property."

In 1933, the IRS ruled that basis should be apportioned on a so-called part sale/partgift. I.T. 2681, XII-1 C.B. 93 (1933). However, in 1939 the U.S. Board of Tax Appealsheld that no gain was realized when a taxpayer sold appreciated property at cost, andafter a short period of nonacquiescence, the IRS acquiesced. Fincke v. Commissioner,39 B.T.A. 510, 516 (1939), nonacq. 1939-1 C.B. 47, withdrawn and acq., 1939-2 C.B.12. The Supreme Court later approved the method under which the entire basis mayoffset the amount realized on a transfer partly by sale and partly by gift. Diedrich v.Commissioner, 457 U.S. 191, 199-200 (1982).

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illogical, arbitrary, and inconsistent with the general rule for partialsales. s A bargain sale, it is argued, is really two separate transfers.9

In one transfer, part of the property is sold for fair market value. In theother transfer, the remaining part is the subject of a gift. From thecharacterization of the transaction as partly a sale and partly a gift, itfollows that basis should be apportioned between the part sold and thepart given.

Curiously, critics of the current treatment of bargain sales regard thegeneral apportionment rule as self-evidently correct and do not considerwhether allowing the entire basis to offset the amount realized on abargain sale might be justified. 0 While this Article defends the rule

8. The Treasury has stated, "The logical treatment is to allocate part of the basisto the gift portion, and part of the basis to the sale portion." 1976 IRS GCM LEXIS274, at *32-*33, available in LEXIS, FEDTAX Library, GCM File.

An article in the Tax Law Review, which argues that Fincke, supra note 7, was"probably decided incorrectly," characterizes allowing the entire basis to offset theamount realized on a bargain sale as "arbitrary." James J. Freeland et al., Part Gift-PartSale: An Income Tax Analysis With Policy Considerations, 47 TAX L. REV. 407, 409-10& n.25 (1992). The article further states, "[C]onsistency would be served by extendingthis bifurcation treatment [i.e., apportioning basis] to all part gift-part sales." Id. at 422.

Although criticizing the current treatment of so-called part sale/part gift transactions,the Freeland article stops short of actually recommending that basis be apportioned,because "the fair market value of the property must be known in order to computeproperly the gain to be recognized on the transfer." Id. at 422. However, the articledoes advocate apportionment (referred to as "bifurcation") for purposes of determiningthe holding period of the property in the hands of the transferee of a part sale/part gift,which admittedly would require knowing "the fair market value of the asset transferred."Id. at 425. There is no indication why, if fair market value is to be determined forbifurcating the property for holding period purposes, that same determination of fairmarket value cannot also be used to apportion basis. Moreover, there is no explanationwhy determining fair market value is more difficult in a part sale/part gift than in otherpartial sales of property, in which basis is apportioned. In any event, whenever a so-called part sale/part gift occurs, the value must be determined for gift tax purposes.

Other commentators have also assumed that allowing the entire basis to offset theamount realized on a bargain sale is wrong and that apportionment is the correct result.See MARVi A. CHiRELSTEN, FEDERAL INCOME TAXATION: A GUIDE TO THE LEADINGCASES AND CONCEPTS 281 (1994) (describing the current treatment of bargain sales an"odd result"); Marjorie E. Kornhauser, The Constitutional Meaning of Income and theIncome Taxation of Gifts, 25 CONN. L. REv. 1, 17 n.68 (1992).

9. "The typical part gift-part sale often involves a single asset, but is, bydefinition, always comprised of two simultaneous, yet distinguishable transactions."Freeland et al., supra note 8, at 421.

10. One might note that neither Board of Tax Appeals in Fincke, 39 B.T. 510,which established the current rule for bargain sales, nor the Supreme Court in Diedrich,457 U.S. 191, which endorsed this rule, explained why it was rejecting apportionmentin favor of allowing the entire basis to offset the amount realized on a bargain sale.

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apportioning basis on partial sales generally, it also concludes thatfrontloading rather than apportionment should apply to bargain sales.

Part II explains apportionment of basis on partial sales as a conse-quence of taxing gain from a particular asset, rather than from aportfolio, perspective. Part m provides four arguments which supportfrontloading, that is allowing the entire basis to offset the amountrealized, on a bargain sale. First, a bargain sale is more plausiblycharacterized as a single unitary transfer in which the entire basis shouldoffset the amount realized, rather than as two separate transfers in whichthe basis must be apportioned between the part sold and the part given.Second, allowing the entire basis to offset the amount realized on abargain sale is consistent with the Code's treatment of ordinary gifts ofappreciated property. Third, frontloading is more equitable thanapportionment because it does not favor the prosperous taxpayer whocan afford an outright gift over a less affluent transferor who may needreimbursement of the original cost. Fourth, frontloading may be easierto administer than apportionment." Part IV argues, however, that inthe special case of a bargain sale to charity, basis should be apportionedin order to limit charitable deductions of unrealized appreciation.

II. THE GENERAL APPORTIONMENT RULE FOR PARTIAL SALES

A. The Unwarranted Presumption Favoring Apportionment

The general rule apportioning basis on partial sales seems to beregarded as presumptively correct.'2 This regard is similar to theunwarranted deference accorded proportionality in other contexts, for

11. In principle, we could construct a mathematical function specifying therelationship between different basis methods and factors relevant to social welfare, suchas equity, allocative efficiency, and administrative feasibility. See generally JosephBankman & Thomas Griffith, Social Welfare and the Rate Strncture: A New Look atProgressive Taxation, 75 CAL. L. REv. 1905 (1987). We would then solve the functionto determine which basis method maximizes social welfare. In practice, suchmathematical precision escapes us. Tax policy is a social, not a laboratory, science.Controlled experiments, which directly measure the relationship between the method ofassigning basis and factors affecting social welfare, are not possible. Indirect measures,even when generated by sophisticated statistical techniques, are of doubtful reliability.See, e.g., Daniel Shaviro, The Minimum Wage, the Earned Income Tax Credit, andOptimal Subsidy Policy, 64 U. CHI. L. REv. 405, 438-39 (1997); George R. Zodrow,Economic Analysis of Capital Gains Taxation: Realizations, Revenues, Efficiency andEquity, 48 TAx L. Rv. 419 (1993). The best that we may be able to do is suggestrelevant considerations and describe the probable consequences of different methods ofassigning basis.

12. See supra note 6.

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example, in favor of a proportional rate structure13 or a proportional(that is, straight-line) method of depreciation. 14 However, the proposi-tion that the fraction of the basis assigned to the part sold should equalthe fraction of the value of the property sold is not itself an argument insupport of the proposition. Rather, it is a tautology, tantamount to nomore than an assertion that the proposition is correct. A more carefulanalysis is needed, examining arguments for and against each of thethree possible basis methods, namely frontloading, apportionment, andbackloading.

B. The Realization Principle

The considerations that shape the tax law's definition of realizationmay also help explain why the tax law generally apportions basis on apartial sale. Under an "ideal" income tax, it might be preferable to taxappreciation in the value of property as it accrues, rather than deferringtax until realization. However, accrued gains may be difficult tomeasure, and taxpayers may lack sufficient liquid assets with which topay a tax on accrued gains. 5 Thus, considerations of measurement andliquidity receive the most weight in the tax law's definition of realiza-tion.

Nevertheless, realization is not defined to include all instances inwhich measurement and liquidity are not a problem or to exclude allinstances in which measurement and liquidity obstacles exist. Accruedgains on publicly traded securities are not considered realized eventhough easy to measure and liquid, perhaps in order to treat consistentlyfungible and nonfungible property. Gain on the exchange of one itemof property for another property is considered realized, notwithstandingmeasurement and liquidity obstacles, presumably in order to prevent

13. For an example of the deference accorded proportional tax rates, see generallyWALTER J. BLUM & HARRY KALVEN, JR., THE UNEASY CASE FOR PROGRESSIVETAXATION (1953). For an explanation of why this deference is unwarranted, seegenerally CHARLES 0. GALVIN & BORIS I. BITTKER, THE INCOME TAX: HowPROGRESSIVE SHOULD IT BE? (1969).

14. For criticims of the deference accorded the proportional allocation ofdepreciation deduction through the straight-line method, see CHIRELSTEIN, supra note 8,at 147-49, and 1 BrrrKER & LOKKEN, supra note 2, 23.1.4.

15. See William D. Andrews, A Consumption-Type or Cash Flow Personal IncomeTax, 87 HARv. L. REV. 1113, 1141-43 (1974); David Slawson, Taxing as OrdinaryIncome the Appreciation of Publicly Held Stock, 76 YALE L.J. 623, 623-26 (1967).

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indefinite tax deferral through barter. Thus, at times other objectives,such as consistent tax treatment16 and preventing indefinite tax defer-ral, 7 may outweigh measurement and liquidity considerations indefining realization for purposes of the tax law.

C. Accurate Measurement and Frontloading

Frontloading has the advantage of eliminating measurement obstacles.This method does not require determining the market value of the entireproperty in order to measure gain on a partial sale, because the entirebasis may offset the amount realized from the part sold. In contrast,both apportionment and backloading require determining the marketvalue of the entire property in order to measure the gain. Underapportionment, this value must be known in order to calculate whatfraction of the value has been sold and accordingly what fraction of thebasis of the entire property to assign to the part sold.'8 Underbackloading, the value must be known in order to determine the amountof gain on the entire property and accordingly the extent to which theamount realized may be taxed.

If property is fungible, the value of the entire property may be easyto determine by observing the price at which identical property sells ona public market. 9 Even if the property is not fungible, it may bepossible to infer the value of the whole, provided the property is uniformin character and the physical proportion sold can be specified. Forexample, if a twenty-acre parcel of land varies little in its characteristics,the amount realized from selling five acres can be multiplied by four toinfer the value of the entire twenty-acre parcel.2"

If property is not fungible and if it is impractical to infer the value ofthe whole as indicated above, courts have occasionally created an

16. Inconsistent treatment may cause both inequity and allocative inefficiency,although the degree of inequity seems to be inversely related to the degree ofinefficiency. See Boris I. Bittker, Equity, Efficiency, and Income Theory: DoMisallocations Drive out Inequities?, in THE ECONOMICS OF TAxATION 19, 19-31 (HenryJ. Aaron & Michael J. Boskin eds., 1980).

17. Tax deferral reduces revenue. Either the lost revenue must be supplied fromother sources, or government spending must be reduced.

18. See Freeland et. al., supra note 8, at 422. Treas. Reg. §1.61-6(a) (1957)requires that basis be "equitably apportioned." The Code provision that requiresapportionment of basis on a bargain sale to charity states, "[The adjusted basis fordetermining the gain from such sale shall be that portion of the adjusted basis whichbears the same ratio to the adjusted basis as the amount realized bears to the fair marketvalue of the property." § 1011(b).

19. "Fungible property" means property of which "any unit is, by nature or usageof trade, the equivalent of any other like unit." U.C.C. § 1-201(17) (1989).

20. See Treas. Reg. § 1.61-6(a), ex. 1.

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exception to the apportionment rule and permitted basis to befrontloaded.21 For instance, in Inaja Land Co. v. Commissioner, thecourt held that, on the sale of an easement in real property, the entirebasis could offset the amount realized.22 Inaja may appear to stand forthe general proposition that basis may be frontloaded whenever adifficult subjective appraisal is required to apportion basis. Nevertheless,Treasury Regulations attempt to limit the effect of Inaja to its precisefacts, namely the sale of an easement in real property,' and to require

21. See, e.g., Inaja Land Co. v. Commissioner, 9 T.C. 727 (1947); Fasken v.Commissioner, 71 T.C. 650 (1979).

22. Inaja, 9 T.C. at 736. In Inaja, the taxpayer sold a perpetual easement topollute waterfront property to the city of Los Angeles for $50,000. Id. at 730-32. Thebasis of the property as a whole was approximately $61,000. Because of the difficultyof determining what fraction of the original property the easement constituted, the TaxCourt held that the entire basis could offset the amount realized from selling only theeasement. Id. at 736.

The Tax Court justified the result by the "impracticality" and "impossibility" ofapportioning basis in the specific case before it.

Petitioner does not contest the rule that, where property is acquired for a lumpsum and subsequently disposed of a portion at a time, there must be anallocation of the cost or other basis over the several units and gain or losscomputed on the disposition of each part, except where apportionment wouldbe wholly impracticable or impossible. Petitioner argues that it would beimpracticable and impossible to apportion a definite basis to the easementshere involved, since they could not be described by metes and bounds....

Id. at 735-36 (citation omitted).What did the court mean when it said that basis could not be apportioned, since the

easements could not be described by metes and bounds? Presumably, it meant thatapportioning basis could not be done objectively, but only with the aid of "impractica-ble" and "impossible" subjective appraisals.

Metes and bounds refer to physical measurements of the dimension of real property.If the part disposed of can be described by physical dimensions, then it may be easy tocalculate the fraction sold by dividing the area sold by the area of the property as awhole. However, in Inaja the easement could not technically be described as a physicalproportion of the entire property. Determining the ratio of the easement to the wholewould have required a subjective estimate. While such an estimate was not literally"impossible," it might nevertheless have been unreliable.

23. IRS Rulings have permitted explicit exceptions to apportionment only in thecase of the sale of an easement. See, e.g., Rev. Rul. 59-121, 1959-1 C.B. 212; Rev. Rul.68-291, 1968-1 C.B. 351.

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apportionment in other cases24 in which a subjective estimate of valuemay be required.'

The Treasury's rejection of frontloading even in cases requiringsubjective appraisal, except for the Inaja precedent, reflects a judgmentthat only extraordinary measurement difficulties should permit deferralof gain on a partial sale.26 This rejection of frontloading, however,does not explain why, of the two remaining options, the tax lawgenerally prefers apportionment over backloading for determining basisand thereby measuring the gain on a partial sale. If anything, a desireto limit deferral should result in the backloading of basis in order to taxgain as soon as possible, rather than the current apportionment rule.

D. Choosing Between Apportionment and Backloading

Apportionment might be preferred over backloading through aformalistic application of the realization principle. If only a portion ofappreciated property is sold, then only the gain attributable to thatportion is realized, in the sense of being the subject of a sale orexchange. The gain attributable to the portion sold equals the amountrealized, minus a proportionate share of the basis. Accordingly, basis

24. The sale of an option to acquire property is arguably a partial sale of theunderlying property. The buyer will presumably exercise the option if the propertyincreases in value above the strike price. The owner therefore has sold a part of theproperty consisting of the right to profit from any increase in value above the strikeprice. However, "the taxable event occurs when the option is exercised or expires,"because until then it is impossible to determine whether the amount received by thetaxpayer granting the option is ordinary income generated by the unexercised option orpart of the amount realized from the underlying property, generating gain or loss afterthe adjusted basis is taken into account. 2 BrrTKER & LOKKEN, supra note 2, T 40.8.3.While the difficulty of apportioning basis to the option might justify frontloading ofbasis and treating the option sale as a taxable event, the additional difficulty ofdetermining the character of the gain justifies delaying any tax at all until exercise orlapse. See also Bruce Kayle, Realization Without Taxation? The Not-So-ClearReflection of Income From an Option to Acquire Property, 48 TAX L. REV. 233 (1993);Calvin H. Johnson, Taxing the Income from Writing Options, 73 TAX NoTES 203 (Oct.14, 1995).

25. Treas. Reg. § 1.61-6(a), ex. 2 appears to require a subjective appraisal in orderto apportion basis on a partial sale. A taxpayer acquires for a lump sum a used car lotand a filling station and later sells the filling station alone.

26. Treas. Reg. §1.61-6(a) states, "[G]ain or loss shall be determined at the timeof sale of each part and not deferred until the entire property has been disposed of."

There has been an analogous development in the law applicable to installment sales.In 1980, Congress enacted § 4530) to "reduce substantially [t]he justification for treatingtransactions as 'open."' S. Rep. No. 96-1000, at 24 (1980), reprinted in 1980U.S.C.C.A.N. 4696, 4719. Prior to the enactment of § 453(j), the open transactiondoctrine permitted the frontloading of basis when future payments under an installmentcontract were subject to contingencies and therefore could be estimated only throughdifficult subjective appraisals. See Bumet v. Logan, 283 U.S. 404 (1931).

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must be apportioned on a partial sale so that only that gain which istruly realized is taxed.

Nevertheless, backloading of basis could also be defended by focusingon the practical considerations of accurate measurement and liquidity,which are said to require the realization principle in the first place. Asnoted above, both apportionment and backloading require knowing themarket value of the property as a whole. Therefore, the possibledifficulty of appraisal does not justify choosing one method over theother. Moreover, liquidity should not pose an obstacle to backloading.Recall that backloading taxes the gain on the entire property only up tothe amount realized. Provided that the amount realized consists of cash,the taxpayer has liquid assets with which to pay the tax assessed underthe backloading method.

True, the effect of backloading basis is to tax both the realized gainon the part sold and the formally unrealized gain on the part that remainsunsold. Nevertheless, the practical considerations supporting the deferralof taxation, namely difficulty of measurement and lack of liquidity, donot afford grounds for preferring apportionment to backloading.Apportionment therefore can be justified as preferable to backloadingonly with reference to some other factor.

E. Measuring Gain: A Specific Asset orPortrolio Frame of Reference?

On the sale of an asset, gain is generally figured with respect to theappreciation on that asset alone and without regard to appreciation onother assets in the taxpayer's portfolio. To illustrate, consider thefollowing example. A owns property W, with a basis of 100 and valueof 200, and property X, with a basis of 100 and value of 200. B ownsproperty Y, with a basis of zero and a value of 200, and property Z, witha basis of 200 and a value of 200. Suppose that each decides to sellproperty in order to raise cash. A sells property W, and B sells propertyZ. Under the existing income tax, gain is calculated with reference tothe amount realized from and the basis assigned to the specific assetsold. Thus, A reports 100 of gain on selling W, and B reports zero gainon selling Z.

The only difference between the two taxpayers is the specific assetseach owns and the relative amounts of unrealized gain on each asset.Except for this difference in the amount of gain on particular assets, A

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and B are in the same economic position. Each initially owns propertywith a total basis of 200 and a total value of 400 and thus has 200 inunrealized property gain. Each then sells 200 worth of property forcash. Why should they be taxed differently?

One could imagine a realization-based system under which they wouldin fact be taxed the same.27 The taxable gain arising from the sale ofa particular asset would be figured with reference to the total gain on allassets in the taxpayer's portfolio. Such a system could employ either anapportionment rule (taxing a fraction of the amount realized as gainequal to the ratio of gain to market value of the entire portfolio) or abackloading rule (taxing the amount realized as gain to the extent of gainon the entire portfolio).

However, a portfolio perspective would require measuring accuratelythe amount of gain on, and hence the market value of, the taxpayer'sentire portfolio of assets. In the absence of a sale of the entire portfoliofor cash, such a measurement could require subjective appraisals. Thedifficulty of making such appraisals is in fact a principal reason forinstituting the realization principle in the first place, rather than taxingproperty gains on accrual. These same measurement obstacles alsoexplain why the Internal Revenue Code generally calculates taxable gainon the sale of an asset by looking at that specific asset alone, withoutreference to the taxpayer's entire portfolio.

F The Specific Asset Perspective and Apportioning Basis

Apportionment of basis follows from the fact that, when a taxpayersells an asset, gain is calculated with respect to the appreciation on thatasset alone and without regard to the appreciation on other assets in thetaxpayer's portfolio. If partial sales are to be treated in a mannerconsistent with other sales of property, then gain on a partial sale alsoought to be determined with respect to the appreciation on the specificpart sold and without respect to any other gain, including gain on thepart of the property that is not sold. The apportionment rule achievesthis result by limiting the amount of taxable gain to the gain on thespecific part sold. A backloading of basis rule, by contrast, would tax

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27. One modest step in the direction of measuring gain from a portfolioperspective is the recent Treasury proposal to assign a basis to any security equal to theaverage basis of all identical securities held by the taxpayer. See Department of theTreasury, General Explanation of the Administration's Revenue Proposals 70-71 (1996).

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not only the gain on the specific part sold but also the gain on thefraction of the property that is not sold.28

A backloading rule for partial sales would also treat taxpayersdifferently, depending on whether they acquired property piecemeal oras a whole. To illustrate, assume that C and D each own ten acres ofland, acquired at a cost of 100 an acre, and that C acquired the propertyacre by acre in ten separate transactions, whereas D acquired the tenacres in a single transaction. If C disposes of one acre for 200, C willrealize a gain of 100, equal to the amount realized from selling the acre,minus the 100 basis. C's gain or loss is calculated only with respect tothe specific asset sold and not with reference to the unrealized gain onthe other separately acquired properties.

If D disposes of one acre for 200 and basis is apportioned, D will alsorealize a 100 gain. D's gain or loss is calculated with respect to thespecific part sold and not with reference to the unrealized gain on therest of the property. Backloading for this partial sale, on the other hand,would result in D's reporting the entire 200 amount realized as gain,without any offsetting basis. 29

To summarize the points so far, the Treasury has rejected frontloadingof basis on a partial sale, even when measurement is difficult, in orderto limit tax deferral. The most important considerations in definingrealization, accurate measurement and liquidity, offer no more supportfor apportionment than for backloading. A preference for apportionmentover backloading can be justified by the idea that gain on the sale of anasset is generally figured only with respect to that particular asset, ratherthan with reference to the taxpayer's entire portfolio.

28. On the other hand, society might decide that consistent treatment is lessimportant than limiting the deferral of taxation afforded by the realization principle. Ifwe place more importance on limiting this deferral advantage, then backloading mightbe chosen over apportionment.

29. If backloading did apply to partial sales, D might arrange to acquire the 10-acre plot piecemeal, for example, in 10 formally separate transactions. Under such anarrangement, the disposition of a single acre would appear to be an entire (rather thana partial) disposition of property, and gain would be measured with reference to thatspecific acre alone. In order to enforce a backloading rule, we would have to recast theformally separate transfers as a single acquisition. See infra note 33 (discussing thisproblem in more depth).

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G. Specific Code Provisions Which Backload Basis

Notwithstanding the general apportionment rule, several Code sectionsprovide a different result when property is exchanged in part for otherproperty that may be received without the recognition of gain, and inpart for cash (or for other property) whose receipt produces recogni-tion.3° For example, suppose that property with a basis of 100 andvalue of 200 is exchanged for like-kind property worth 100 plus cash of100. This transaction constitutes partly a like-kind exchange and partlya sale for cash.

If basis were equitably apportioned, one-half of the 100 basis of theoriginal property would be assigned to the partial sale. The transferorwould accordingly report 50 of gain.3 Instead, the Code taxes the 100amount realized in full (up to the gain on the entire property), withoutany basis offset.3" In effect, basis is backloaded with respect to thereceipt of cash (or other property).33

30. The transactions and applicable Code sections include: the exchange ofproperty for like-kind and nonlike-kind property under § 1031(b); the involuntaryconversion of property into similar and dissimilar property under § 1033(a)(2); therollover of the proceeds from selling a principal residence into a new principal residenceand other property under § 1034 (repealed 1997); the exchange of property for stock andother property in a controlled corporation under § 351(b); and a nondividend distributionby a corporation with respect to stock under § 356(a).

31. In a similar vein, suppose that property with a basis of 100 and value of 200is destroyed by fire and that the taxpayer uses only 100 of 200 of insurance proceeds toacquire property "similar or related in use." The transaction constitutes partly aninvoluntary conversion into similar property and partly a sale for cash. Underapportionment, the taxpayer would report 50 of gain. However, section 1033(a)(2) ineffect backloads basis by taxing the entire 100 gain.

32. See § 1031(b).33. To avoid this result, taxpayers may attempt to disaggregate the transaction into

two separate transfers. The first transfer would involve the sale of part of the originalproperty for cash, in which basis is apportioned to the part sold under Treas. Reg.§ 1.61-6(a) (1957), followed by a second formally separate exchange of the remainingpart of the original property for like-kind property.

Of course, if two transfers occur on or about the same date and with the sametransferor and transferee, then the IRS may try to recast the transfers as a unitaryexchange of the original property for like-kind property plus cash. Nevertheless, it maybe difficult for the IRS to discover when formally separate transfers are in factinterdependent since taxpayers have the initiative in the design and execution. The IRShas a greater chance of success when a contract or other writing explicitly refers to theinterdependence of formally separate deals.

Redwing Carriers, Inc. v. Tomlinson, 399 F.2d 652 (5" Cir. 1968), demonstrates acourt's handling of a case involving an interdependence of formally separate deals. InRedwing, the taxpayer sold used trucks to General Motors for cash. Id. at 655. Withina few weeks, a wholly owned subsidiary of the taxpayer bought new trucks from GeneralMotors for cash. Id. Testimony at trial established that the sale of used trucks toGeneral Motors by the taxpayer was conditioned on the purchase of new trucks from

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In failing to provide for apportionment of basis in what might becalled part taxable sale/part nonrecognition transactions, Congress maynot have been aware that it was departing from the general apportion-ment of basis rule. The inconsistency between these Code provisionsand the general apportionment rule may therefore be accidental ratherthan deliberate, one of the many discontinuities resulting from theconvoluted, complex process of enacting and amending the InternalRevenue Code.

If Congress wants to treat these transactions in a manner consistentwith ordinary partial sales, it could amend the Code to provide forapportionment.34 On the other hand, Congress may believe thatlimiting the deferral advantage afforded by the realization principle ismore important than consistent treatment. If so, perhaps these Code

General Motors by the taxpayer. Id. Consequently, the court held that under § 1031 thetwo transactions should be integrated and treated as an exchange of used trucks, plus thenet amount of cash transferred by the taxpayer, for new trucks. Id. at 654, 659.

Other cases discussing this issue include Diedrich v. Commissioner, 457 U.S. 191(1982), and Cottage Say. Ass'n v. Commissioner, 499 U.S. 554 (1991). In Diedrich, thetaxpayers made a gift of property to their children. Diedrich, 457 U.S. at 192. The giftwas explicitly conditioned on the children agreeing to pay the gift tax owed by thetaxpayers. Id. Therefore, the court treated the parents as transferring the property inreturn for the children's agreement to pay the gift tax. See id. at 198-99.

In Cottage Savings, the taxpayer sold a mortgage pool to another institution for cash.Cottage Savings, 499 U.S. at 557. A federal regulatory agency required in a writtenmemorandum that the taxpayer simultaneously buy a mortgage pool with about the samevalue from the other institution for cash. Id. Therefore, the court found the transactionsto be interdependent and treated them as an exchange of one mortgage pool by thetaxpayer for another mortgage pool. See id. at 557-58.

34. In addition to the statutory provisions described above, the tax law generallydoes not allow any portion of basis to offset the sale of a carved-out term interest.Instead, the amount realized from the partial sale is taxed in full if the part sold is a terminterest in property. Cogent reasons for an exception to the general apportionment ruledo exist in this instance. The sale of the term interest creates a future interest, whichincreases in value over time as the term interest declines in value. The tax law usuallyfinds it difficult to tax this increasing value of the future interest properly. The terminterest is taxed in full, without any basis offset, as a surrogate or substitute for taxingthe increasing value of the future interest. Alternatively, the tax law could apportionbasis to the sale of a term interest if the increasing value of the future interest wereproperly taxed, as in the case of original issue discounts under § 1272 and strippedbonds under § 1286. See generally William D. Popkin, The Deep Structure of CapitalGains, 33 CASE W. RES. L. REV. 153 (1983); Jeffrey L. Kwall, The Income TaxConsequences of Sales of Present Interests and Future Interests: Distinguishing Timefrom Space, 49 OHIO ST. L.J. 1 (1988); Noel B. Cunningham & Deborah H. Schenk,Taxation Without Realization: A "Revolutionary" Approach to Ownership, 47 TAX L.REV. 725 (1992).

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provisions should be left unchanged and backloading should be adoptedfor partial sales generally.

H. Frontloading Basis for Acquisition Indebtedness

In addition to Code provisions that backload basis, there are also a fewprovisions that frontload basis. The most important provisions affect thetransfer of property to a controlled corporation in exchange for stockplus the assumption of liabilities.35 Basis is frontloaded if there is notax avoidance purpose, as for example, if the liabilities were incurred inorder to finance acquisition of the transferred property. As a result,provided assumed liabilities do not exceed the property's basis, thetransferor reports no gain.36

The critical point is that the frontloading of basis in this instancereflects a policy judgment. The incorporation of business property, withassociated liabilities no more than basis, simply changes the form ofbusiness organization. The transferor does not actually withdraw cashor other property from the ongoing enterprise. 7 Consequently, it is notan appropriate occasion for taxing gain?. The current rule that

35. See § 357(a), (c). An area of only minor consequence is the treatment of anondividend distribution with respect to stock that is not out of earnings and profits.Under subsections 301(c)(2) and (c)(3), the amount realized constitutes gain only to theextent that it exceeds the stock's basis. A nondividend distribution is difficult todistinguish from a capital gain redemption in which only the basis of redeemed sharesis available under § 302(b) to offset the amount realized.

36. To illustrate, assume that land costing 100 is acquired for a cash downpayment of 20 and a mortgage of 80. Later, when the land has appreciated in value to200 and the outstanding mortgage principal is reduced to 50, it is transferred to acontrolled corporation in return for stock plus assumption of the remaining 50 mortgage.Ordinarily, the mortgage assumption would be treated as the equivalent of receivingcash, so that the transferor would report 50 of gain under § 351(b). However, by virtueof subsections 357(a) and (c), the transferor may use the entire basis to offset themortgage assumption, thereby reporting no gain.

37. On the other hand, suppose that the property had been mortgaged some time,.fter acquisition and that the proceeds had been used to finance the transferor's personalconsumption. In that event, the purpose would be considered one of tax avoidance, andthe mortgage assumption would be treated like the receipt of any other nonqualifyingproperty. The transferor, in other words, would be treated as if the transferee, insteadof assuming the mortgage, had simply paid the transferor an equivalent amount in cash.See § 357(b) (addressing assumption of liability for tax avoidance purposes).

38. Curiously, this reasoning has not been extended to other nonrecognitionprovisions. For example, suppose that property is exchanged for like-kind property plusassumption of acquisition debt. Under § 1031(b), the gain is taxed to the extent of theassumed debt. See Treas. Reg. § 1.1031(b)-l(c) (as amended in 1967) (defining nonlike-kind property to include the relief of mortgage liabilities); Treas. Reg. § 1.1031(d)-2, ex.1 (1960) (providing an example of property exchanged in part for assumption of debt).

Taxing the gain, however, seems inconsistent with the purpose of § 1031, since theinvestment in like-kind property continues unabated, without the withdrawal of cash or

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allocates the entire basis to a bargain sale of property ought to be judged

by a similar standard.

I1. BASIS ON A BARGAIN SALE

A. The Critique of Current Law

The case law and administrative practice do not apply the apportion-ment of basis rule for partial sales to a bargain sale, in which propertyis intentionally sold for less than fair market value.39 Instead of beingapportioned, up to the entire basis may offset the amount realized froma bargain sale.

As noted above, this result has been criticized as illogical, arbitrary,and inconsistent with the general apportionment of basis rule. A bargainsale, it is argued, consists of two separate transfers.4" In one transfer,part of the property is sold for fair market value. In the other transfer,the remaining part is the subject of a gift. From the characterization ofthe transaction as a part sale/part gift, it follows that basis should beapportioned, as for other partial sales.

Nevertheless, four kinds of arguments support allowing the entire basisto offset the amount realized on a bargain sale. First, a bargain sale ismore plausibly characterized as a single unitary transfer in which theentire basis should offset the amount realized, rather than as two separatetransfers in which the basis must be apportioned between the part sold

nonlike-kind property. Professor Marvin A. Chirelstein made the following observationon the exchange of property for like-kind property plus assumption of acquisition debt,

[The transferor] has withdrawn no cash at any stage, and as the object of theprovision is to defer recognition until the original property is converted tomoney or dissimilar assets, it would seem consistent for [the transferor] torecognize no gain on the mortgage transfer .... The section follows adifferent course, however ....

CHIRELSTEIN, supra note 8, at 292.With careful planning, taxpayers may be able to design around this problem by

seeking out like-kind property encumbered by a mortgage at least equal in amount to themortgage to be assumed in the exchange. Treas. Reg. §1.1031(b)-l(c) provides that theamount of nonlike-kind property received is reduced for any mortgages assumed by thetaxpayer. See also Treas. Reg. § 1.1031(d)-2, ex. 2.

39. See supra note 7 and accompanying text.40. "The typical part gift-part sale often involves a single asset, but is, by

definition, always comprised of two simultaneous, yet distinguishable transactions."Freeland et. al., supra note 8, at 421.

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and the part given. Second, allowing the entire basis to offset theamount realized on a bargain sale is consistent with the Code's treatmentof ordinary gifts of appreciated property. Third, this method ofallocating basis is more equitable than apportionment because it wouldnot favor the prosperous taxpayer who can afford an outright gift overa less affluent transferor who may need reimbursement of the originalcost. Fourth, this method may be easier to administer than apportion-ment.

B. Two Separate Transfers or a Unitary Sale?

The part sale/part gift label, preferred by the critics of current law,may itself distort the analysis of how to determine basis. Part sale/partgift implies that there really are two separate transactions: a sale of partof the property for fair market value and a gift of the other part. Whilepart sale/part gift is one way of characterizing the transaction, it does notdescribe what we directly observe. We do not actually observe twoseparate transactions, but only a single transaction: the sale of propertyfor less than its value. It is more accurate to describe the transaction, atleast initially, as the intentional sale of property at a bargain price, or asa bargain sale for short.4"

Labeling the transaction as a bargain sale advances the analysis of howto determine basis. The label makes clear that it is plausible tocharacterize the transaction, not as two separate transfers, but rather asa single, unitary transfer in which the transferor is paid less than theproperty's value and in which apportionment is inappropriate because infact the entire property is sold.42 In reality it is mistaken to view thetransferor as selling part of the property for full fair market value, whenthe payment of full market value for part of the property is conditionedon the transfer of the rest of the property for free.43

41. An intentional sale of property at a bargain price should be distinguished fromthe unintended sale of property for less than its value, in which the transferor has notmade a gift but instead has made a bad bargain. This second transaction is referred toas an unintended bargain sale, or as a bad bargain for short.

42. The use of the part sale/part gift label implies that basis should be apportioned,and the use of the bargain sale label implies that the entire basis should offset theamount realized. However, Treas. Reg. § 1.1001-1(e)(1) (as amended in 1994), whichallocates the entire basis to a bargain sale, describes the transaction as a part sale/partgift. while § 1011(b), which provides for apportionment in the case of a part sale/partgift to a charitable organization, describes the transaction as a bargain sale.

43. Nevertheless, some commentators have argued that allowing the entire basisto offset the amount realized on a bargain sale creates an anomaly. They offer thefollowing example to substantiate their argument:

Assume A has corporate stock with a fair market value of $100 and anadjusted basis of $20. If A sells half of the stock to B and gives the remainder

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C. The Realization Principle and Gifts

Although sales of property produce realization of gain to thetransferor, the federal income tax treats ordinary gifts of appreciatedproperty as not producing realization. 4 In addition, the transfereeassumes the transferor's basis,45 so that gain not realized on the gifttransaction will be reported on a taxable disposition by the transferee.46

This treatment of gifts as not producing realization is supported bypractical considerations. If a gift caused taxation to the transferor, theproperty would have to be valued, and the taxpayer might be forced toliquidate assets to pay tax on the gain. However, these measurement andliquidity considerations are not always determinative, as for example,with the exchange of one property for another property, in whichrealization occurs despite such obstacles.47 Moreover, the gift mustusually be valued anyway to determine the gift tax amount.48

Perhaps the decisive factor here is that most gifts of appreciatedproperty are made to family members and simply change who holds

to C, A's gain on the sale is $40 ($50 amount realized-10 adjusted basis(one half of $20)). If, however, A transfers the stock to C for considerationof $50, the gain is $30 ($50 amount realized-$20 adjusted basis). C hasreceived the same $50 gift each time and A the same $50 consideration, butthe part gift-part sale regulation results in $10 less gain realized by A.

Freeland et al., supra note 8, at 410 (citations omitted).This example assumes that two separate transfers-first a sale to one person for fair

market value and second an ordinary gift to a different person-should be treated thesame as the single transfer of all the stock to one person. However, there is no anomalyif society decides to treat a sale of appreciated property for less than fair market valueas a unitary transfer.

44. This view is implicit in §§ 102(a) and 1015(a), which provide that the doneehas no gain on receipt of a gift and that the donee assumes the donor's basis. The twoprinciple exceptions involve already accrued ordinary income and installment obligations.With regard to the first exception, the Supreme Court has held that a gift of interestcoupons shortly before the maturity date causes realization of the accrued ordinaryincome gain to the donor. Helvering v. Horst, 311 U.S. 112, 119 (1940). With regardto the second exception, under § 453B(a) a gift of an installment obligation causestaxation of gain to the donor.

45. § 1015(a).46. A gift of appreciated property therefore defers taxation of gain and shifts the

incidence of taxation.47. See Treas. Reg. § 1.61-6(a) (1957).48. See § 2001.

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formal legal title to property within the family unit.49 Therefore, as amatter of principle, such gifts are not considered an appropriate occasionfor taxing property gains. The decision to treat intrafamily gifts as notproducing realization of gain is not inevitable, and an income tax couldplausibly have reached a different result. For example, first in 1962 andlater in 1969, the Treasury unsuccessfully proposed treating certain giftsas taxable events.5"

Nevertheless, once we decide to treat intrafamily gifts as notproducing realization, the more general outcome of not treating any giftsas taxable events follows on practical grounds. Drawing the linebetween intrafamily and extrafamily gifts is a difficult exercise. Itdepends on whether one defines the family unit narrowly as constitutingthe nuclear family, or broadly as including more distant relations andalso friends. Moreover, even if the family unit is defined narrowly,gifts outside the family unit may be a relatively small proportion of totalgifts. Thus, distinguishing intrafamily from extrafamily gifts is probablynot worth the trouble.

To recapitulate, the federal income tax has generally treated gifts ofappreciated property as not causing taxation of gain. Both principledand practical considerations support this result.

D. The Effect of Allocating the Entire Basis to a Bargain Sale

Provided the price paid is no more than the property's basis, allowingthe entire basis to offset the amount realized on a bargain sale producesexactly the same income tax consequences as an outright gift. Thetransferor realizes no gain,52 and (in order to preserve the unrealizedgain for later recognition) the transferee's basis equals the transferor'sbasis for the entire property.53

49. See William D. Andrews, Personal Deductions in an Ideal Income Tax, 86HARV. L. REv. 309, 354-58 (1972).

50. See President's 1963 Tax Message: Hearings Before the House Ways andMeans Comm., 88' Cong., 1St Sess. 24, 54-55, 128-140 (1963); Hearings on Tax ReformBefore the House Ways and Means Comm., 91st Cong., 1Vt Sess., Pt. 2 3969-4185 (1969).See also Chirelstein, supra note 8, at 58.

51. Andrews, supra note 49, at 350-51.52. Under § 1001(a), gain equals the excess of the amount realized over the

adjusted basis. If the amount realized is no more than the adjusted basis, there can beno excess and therefore no gain.

53. The transferee's basis should preserve any unrealized gain in full for laterrecognition when the transferee disposes of the property. The transferee's basis shouldtherefore equal the transferor's basis, plus any gain realized to the transferor. Providedthat the amount paid is no more than the transferor's basis (so that no gain is realized),the transferee's basis will be the transferor's basis. As a result, taxation of gain isdeferred and shifted to the transferee.

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To illustrate, suppose that property with a value of 200 and a basis of100 is sold for 100. With basis frontloaded, the amount realized is fullyoffset by the entire basis, and the bargain sale, like an outright gift, willnot cause the transferor to realize gain. Because the transferor realizesno gain, the transferee assumes the transferor's 100 basis.

Under apportionment, by contrast, the amount realized would be offsetby only a fraction of the entire basis (equal to the ratio of the amountrealized over the market value of the entire property). With basisapportioned in the above example, the 100 amount realized would beoffset by only 50 of basis, producing 50 of realized gain. In order topreserve the unrealized gain for later recognition (but no more), thetransferee's basis would be 150, which equals the transferor's 100 basisplus the 50 gain realized by the transferor.

E. Analogy to an Ordinary Gift

Consider the following example. Parent buys a $100,000 vacationhome,54 which appreciates in value to $200,000. Parent then transfersthe house to Child, asking to be paid in return only the original$100,000 cost. Should this transfer of appreciated property for no morethan its cost produce realization of gain to Parent? It would if theapportionment rule applied to a bargain sale, as has been proposed. Inthat event, only $50,000, one-half of the original $100,000 basis, wouldbe assigned to the part sold for $100,000, producing realization of$50,000 of gain to Parent.

On the other hand, if we treat an ordinary gift of property as notproducing realization (just as we would the incorporation of a businesswith assumed liabilities no greater than basis), then why not also the sale

Treas. Reg. § 1.1015-4(a) (as amended in 1972) implements this result by providingthat, after a part sale/part gift, the transferee's basis shall equal the amount paid by thetransferee for the property or the transferor's basis, whichever is greater. See Larry D.Ward, Taxation of Gratuitous Transfers of Encumbered Property: Partial Sales andSection 677(a), 63 IowA L. REv. 823, 826-27 (1978).

54. Before 1998, § 121 permitted taxpayers who are 55 years of age or older toexclude up to $125,000 of gain on the sale of a principal residence. Section 1034 alsoprovided for deferral of gain on the sale of a principal residence if the proceeds wereused to acquire a new principal residence within specified time limits. Currently, § 121permits married taxpayers to exclude up to $500,000 of gain and single taxpayers toexclude up to $250,000 of gain, on the sale of a principal residence, regardless of age.Section 1034 has been repealed.

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of appreciated property for no more than its basis? Like an ordinarygift, such a transaction typically occurs between family members andsimply changes who holds formal legal title to property within thefamily unit without altering the income of the unit as a whole. We maydecide that the transaction is analogous to a gift and therefore not anappropriate occasion for taxing gain. Such a decision can be implement-ed by allowing the entire basis to offset the amount realized, so that thetransferor realizes no gain. 5

Moreover, apportionment of basis would unduly favor the wealthiesttaxpayers. A more affluent parent may be able to afford an outright giftof the vacation home without asking to be paid anything. A less affluentparent may need reimbursement of the original cost. Would it be fair totreat the outright gift by the first as not producing realization, but thesale of appreciated property for no more than basis by the second ascausing taxable gain?

The larger message is that assigning basis is not simply a technicalissue, but rather should reflect policy judgments about when to tax gainon property. If we believe that the sale of appreciated property at cost(or less) is an appropriate occasion for taxing gain, then perhaps basisshould be apportioned. On the other hand, if we believe that it is not anappropriate occasion, then current law, which allocates the entire basisto a bargain sale, is the correct result.

F Distinguishing an Intentional BargainSale from a Bad Bargain

Property may be sold for less than fair market value either intentional-ly in order to make a gift or unintentionally as the result of a badbargain. Even if we decided to apportion basis on an intentional bargainsale, the entire basis should still be available to offset the amountrealized from a bad bargain. We would therefore have to distinguish theintentional sale of property for less than fair market value from cases inwhich the transferor has simply made a bad bargain.

Of course, if the bargain amount exceeds the annual gift tax exclusion,the distinction will also have to be made in any event in order todetermine whether the transfer is subject to gift tax.56 The distinctionmay also be required in order to determine the transferee's holdingperiod. Moreover, distinguishing an intentional bargain sale from a bad

55. On the other hand, to the extent that the transferor receives an amount inexcess of the basis, the gain is reported. See Treas. Reg. § 1.1001-1(e), ex. 1 (asamended in 1994).

56. See generally § 2001.

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bargain may not be difficult. If the transferor and transferee are relatedparties, it may be fair to presume that the sale of property for less thanits value is intended. If they are unrelated, it may be reasonable topresume that the sale of property for less than its value is a bad bargain.Nevertheless, related parties sometimes do bargain at arm's length overthe sale of property, and taxpayers sometimes intend to benefit unrelatedparties.

Current law has the advantage (although admittedly minor) ofproviding the same rule for determining basis whether a transfer is anintentional bargain sale or simply a bad bargain. In all cases in whichproperty is sold for less than its value, whether there is a gift or a badbargain, the entire basis is still available to offset the amount realized.

G. Holding Period

Critics of allocating the entire basis to a bargain sale also recommendthat, for purposes of determining the transferee's holding period, a so-called part sale/part gift be bifurcated. On the part sold, the holdingperiod would begin anew as of the date of the transfer, as is the casewith sales.57 On the part given, the transferee would use the holdingperiod already established for the transferor, as is the case with gifts.5

While arithmetically appealing, this recommendation is questionable,given the underlying nature of the transaction in which property is soldat or below cost. If a sale of appreciated property for no more than itsbasis is not an appropriate occasion for realizing gain because thetransaction is considered a unitary transaction, analogous to an outrightgift, then the holding period should be determined in the same manner

57. See § 1223 (addressing the holding period of property).58. Critics have explained their recommendation as follows:In the case of a gift, full tacking is allowed to the transferee, while no tackingresults on a sale. The logical conclusion would seem to be that partial tackingshould apply to a part gift-part sale. To illustrate, again assume D ownsproperty with a fair market value of $40 and a basis of $10. If D sells theproperty to E, an individual, for $20, inherently there is both a sale portion anda gift portion of this transaction. In theory, the sale portion should be treatedas a true sale of property while the gift portion should be treated as a true giftof property. This result would mandate the commencement of a new holdingperiod for the sale portion and the tacking of D's holding period to E's for thegift portion.

Freeland et al., supra note 8, at 413-14 (citations omitted).

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as for an outright gift. The transferee should use the holding period ofthe transferor with respect to the entire property, without bifurcation.

H. Should Complete Nonrecognition Apply?

Current law permits nonrecognition on a bargain sale only to theextent that appreciated property is sold for no more than its basis. It stillrequires gain to be reported to the extent that the amount realizedexceeds the property's basis. But why require recognition of gain onintrafamily sales in which the amount realized does exceed basis? Suchsales, by definition, simply rearrange who holds title within the family,so why recognize the gain. These questions spotlight the rationale forallocating the entire basis on a bargain sale. Perhaps this rationale couldjustify nonrecognition on intrafamily sales of appreciated property formore than the basis, as the Code now provides for sales betweenhusband and wife.59

As a practical matter, however, complete nonrecognition in suchinstances would require determining which sales of appreciated property,in addition to transfers between spouses, should be treated as intrafamilytransfers and which should be treated as transfers between separateeconomic units. This is hardly an easy task. Should only sales betweenparents and children be covered, or should the scope be broader toinclude sales with siblings, grandparents, aunts, and uncles? And shouldpersons of a specified relationship be covered without regard to theirrespective ages? At some point in their lives, many children maybecome economically independent of their parents, although they do soat varying ages and to varying degrees.

Nonrecognition should generally apply to intrafamily sales ofappreciated property for more than basis only to the extent that thesedifficulties of definition can be resolved. Current law, which allocatesthe entire basis to a bargain sale, helps to avoid the difficulty ofdistinguishing such intrafamily sales from sales between economicallyindependent units. The same basis method, allowing the entire basis tooffset the amount realized, applies to both kinds of transactions.

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59. In 1984, Congress added § 1041 to the Code for transfers of property effectedafter July 18, 1984. See Tax Reform Act of 1984, Pub. L. No. 98-369, 98 Stat. 793.Section 1041 provides for nonrecognition on all transfers of property between spouses.Id.

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IV. A SPECIAL CASE: BARGAIN SALES TO CHARITY

Although current law generally permits the entire basis to offset theamount realized from a bargain sale, there is one exception. When thetransferee is a charity, basis must be apportioned under the methodgenerally prescribed for partial sales. 60 Consequently, a taxpayerselling appreciated property at a bargain price to a charity is taxed on aportion of the appreciation, even if the amount realized does not exceedthe property's basis.

To illustrate, suppose that stock with a value of 400 and basis of 200is sold for the bargain price of 200. If the buyer is not a charity, theentire basis may offset the amount realized, and the seller reports nogain. However, if the buyer is a charity, then apportionment of basisallows the 200 amount realized to be offset by only one-half of thebasis, or 100, producing 100 of realized gain.

If the entire basis may generally offset the amount realized from abargain sale, as current law provides, why create an exception fortransfers to charities? One answer is that the exception addresses aparticular problem which arises only when the transferee is a charity,namely the Code's allowance of a charitable deduction for unrealizedproperty gains. A taxpayer who makes an outright gift of appreciatedproperty to charity may generally deduct the entire fair market value,even though the appreciation is never taxed to the donor or a memberof the donor's extended household.6" For example, a charitabledonation of stock with a 400 value and 200 basis will ordinarily resultin a deduction of the full 400 value of the property, although none of the200 appreciation has been realized.

60. Section 101 l(b) states:If a deduction is allowable under section 170 (relating to charitable

contributions) by reason of a sale, then the adjusted basis for determining thegain from such sale shall be that portion of the adjusted basis which bears thesame ratio to the adjusted basis as the amount realized bears to the fair marketvalue of the property.

61. However, when appreciation represents potential ordinary income or short-termcapital gain, or in the case of specified tangible personal property, the deduction islimited to the property's basis. § 170(e)(1).

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This allowance of a charitable deduction for unrealized appreciationis controversial. 62 Proponents believe that the benefits to the public, inthe form of increased charitable giving, more than offset the revenueloss. Critics, who obviously disagree, propose two reforms: either treata charitable gift as producing realization to the donor,63 or reduce thecharitable contribution by the amount of unrealized appreciation, therebylimiting the deduction to the property's basis.

Taxpayers frequently try to maximize the degree to which theircharitable gifts consist of unrealized appreciation. However, in the caseof outright gifts, their ability to do this is limited by their supply of low-basis assets. Without apportionment of basis on bargain sales to charity,however, this limit would virtually disappear. Taxpayers could arrangefor a charitable gift to consist purely of unrealized appreciation byselling appreciated property to a charity at cost.64

For example, a taxpayer who owned property with a value of 400 andbasis of 200 could sell it to charity for 200. Without apportionment, thetaxpayer would realize no gain and at the same time deduct the 200bargain element as a charitable contribution. With apportionment, on theother hand, the taxpayer is forced to realize 100 of gain, which reducesthe amount of unrealized appreciation being deducted from 200 to 100.Requiring apportionment of basis on a bargain sale to charity thereforemight be justified as limiting the ability of taxpayers to create acharitable deduction consisting solely of unrealized appreciation.65

V. CONCLUSION

Once a bargain sale is labeled as a part sale/part gift, measuringtaxable gain appears to be a simple matter of applying the general

62. See, e.g., Cherie J. O'Neil et al., Reassessing the Tax-Favored Status of theCharitable Deduction for Gifts of Appreciated Assets, 49 NAT'L TAX J. 215 (1996).

63. Accurate measurement and liquidity are not obstacles to treating a charitablegift (as opposed to an ordinary gift) as producing realization of gain. The property mustbe valued anyway in order to determine the amount of the charitable deduction.Realized gain is at least offset by the deduction, so there is no additional tax imposedas a result of a charitable gift producing realization to the donor and therefore no needto liquidate assets to pay the tax.

64. Professors Boris I. Bittker and Lawrence Lokken note that, withoutapportionment:

[A] taxpayer who sold appreciated property to a charity for its adjusted basisdid not realize gain (since the amount realized did not exceed the property'sadjusted basis) and could deduct the difference between the sales price and theproperty's fair market value as a charitable contribution. In effect, therefore,taxpayers could make deductible gifts of "pure" appreciation.

2 BITrKER & LOKKEN, supra note 2, 35.2.4.65. I am grateful to Daniel Halperin for pointing out to me this justification for

§ 1011(b).

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apportionment rule for partial sales. Calculate the fraction of theproperty sold and allow the same fraction of the property's basis tooffset the amount realized.

However, on closer examination, policy reasons favor allowing theentire basis to offset the amount realized on a bargain sale of appreciatedproperty. First, a bargain sale is more plausibly characterized as a singleunitary transfer in which the entire basis should offset the amountrealized, rather than as two separate transactions requiring apportionmentof basis between the part sold and the part given away. Second, like anordinary gift, the sale of appreciated property for no more than basistypically occurs between family members and simply changes who holdsformal legal title to property within the family unit. By allowing up tothe entire basis to offset the amount realized, current law ensures that abargain sale of property for no more than basis will not result in tax.Third, unlike apportionment, this method does not favor the prosperoustaxpayer who can afford an outright gift over a less affluent transferorwho may need reimbursement of the original cost. Fourth, this methodis somewhat easier to administer because the same rule determines basisregardless of whether a transfer is an intentional bargain sale or a badbargain.

The larger message is that assigning basis is not simply a technicalmatter. The basis method determines when gain will be taxed. Societymay or may not conclude, as a policy matter, that a particular transactionis an appropriate time to tax gain. Whatever the conclusion, it issociety's judgment on this issue which should guide the choice of thebasis method.

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